FREEKY BUSINESS

Thursday, 23 January 2014

Some time
ago, a London friend of mine in was diagnosed with a severe medical condition,
which required urgent yet complex surgery. The condition is rare but,
fortunately, there appeared to be several specialists both in Germany and France
who had each treated hundreds of cases during their careers. When it comes to
specialist operations, experience is key, so he was going to visit each of them
and then make a decision.

However, when
I spoke to him again, he had just decided where he was going to have the
operation: in the hospital in his hometown in Spain. I was surprised; there was
no specialist in that hospital. But he explained to me that he had flown to his
home country for another opinion and that the local surgeon had made a good
impression and was very pleasant. Moreover – he added – after the surgery, he
would have to stay in the hospital for two weeks and it would be nice to do
that near his family.

I was
stunned. My friend is a rational guy, in charge of a large company. I have no doubt that, if he had been making
this decision for me, he would have immediately recommended me to go to one of
the real specialists, wherever they were in the world. He would have told me
that where I would spend the two weeks in a hospital bed and whether the
surgeon was a good conversationalist are quite immaterial. But, when making
this important decision for himself, emotional considerations took over. And
unfortunately, the initial operation was not successful, and my friend ended up
having to travel abroad to see one of the specialists anyway.

And many of
us would make the same irrational decision, with the same troubling
consequences. Whether it’s a personal choice or a strategic business decision,
emotions often crowd out objectivity. Precisely because they are such important
choices, loaded with anxiety and uncertainty, when faced with a major decision
people start to “follow their heart”, “rely on intuition” and “gut feeling”, overestimate
their chances of success, and let their commitment escalate.

Good leaders
don’t let their emotional bonds cloud
their judgment. Sound leadership requires objectivity. What can executives do
to remain objective, when it comes to strategic choices: what businesses to
enter, what to focus on and invest in, when to pull the plug and abandon a previous
course of action?Make decision rules beforehand. One way is to develop and set a
clear decision rule beforehand, when there is nothing concrete to decide upon
yet. When Intel was still a company focused on producing memory chips, Stanford
professor Robert Burgelman documented that CEO Gordon Moore had emotional
trouble abandoning this product, which was losing them money, because it “had
made the company” (famously declaring “but, that would be like Ford getting out
of cars!?”), in favor of the much more profitable microprocessors. Yet, the
change happened, because they relied on their so-called “production capacity
allocation rule”.

Gordon
Moore and Andy Grove, well before this actual dilemma became relevant, had put
together a formula – the production capacity allocation rule – to decide what
products would receive priority in their manufacturing plant. When top
management had emotional difficulty deciding to abandon memory chips,
microprocessors were automatically receiving more production capacity anyway,
because middle managers sturdily followed the rule that they had been given
before. Because top management had made the decision what sort of product
should receive production priority well before it became a concrete issue, the strategic
choice became detached from their emotion of the moment.Tap into the wisdom of your crowd. A second method to depersonalize difficult
decisions is to not leave pivotal choices in the hands of one or just a few individuals
– usually top managers – but, instead, to tap into the wisdom of the company’s
internal crowd. When I asked Tony Cohen – the previous CEO of television
producer Fremantle Media, of programs such as the X-factor, American Idol,
Family Feud, and The Price is Right – how he decided what new programs to
invest in he replied “I don’t make that decision”. He resisted making such
crucial investment decisions himself; instead he designed an internal system
that identified the most promising ideas, by tapping into the collective
opinion of his television executives across the world.

For
example, every year, he organized the “Fremantle Market”; an internal meeting in
London where Fremantle executives from all over the world presented their new
ideas (usually in the form of a trail episode). Subsequently, an internal
licensing system made sure that prototype programs that many of them liked
automatically got funded. A particular idea that hardly any of them believed in
would not receive any investment – even if Tony Cohen happened to like the idea
himself. This way, the decision did not rest in the hands of any individual; no
matter how senior.The revolving door approach. Finally, a valuable technique is to explicitly
adopt an outside perspective. Andy Grove, regarding his debates with Gordon
Moore whether to abandon DRAMs, said “I
recall going to see Gordon and asking him what a new management would do if we
were replaced. The answer was clear: Get out of DRAMs. So I suggested to Gordon
that we go through the revolving door, come back in, and just do it ourselves.”
Taking the perspective of an outsider –
a new CEO, private equity firm, or turnaround manager – can help see things
more clearly. Research shows, for example, that people are very bad
at estimating the time it will take for them to complete a project (e.g., write
an assignment; refurbish a house) but they are good at estimating it for
someone else. Asking them to take a third-person perspective has been shown to
help objectivize a process, making someone’s judgment more accurate and
realistic.

When making
important strategic decisions, which are going to decide our faiths and those
of our organizations, it is important to not let emotions and personal
preferences cloud our judgment. Emotional commitment can be good, but not if it
gets in the way of sound decision-making. Depersonalizing decisionmaking can
sound cold or aloof, but it’s the best way to ensure a better outcome, for
ourselves and our companies.

Wednesday, 8 January 2014

For decades, strategy gurus have been telling firms to
differentiate. From Michael Porter to Costas Markides and through the Blue
Oceans of Kim and Mauborgne, strategy scholars have been urging executives to distinguish
their firm’s offerings and carve out a unique market position. Because if you
just do the same thing as your competitors, they claim, there will be nothing
left for you than to engage in fierce price competition, which brings
everyone’s margins to zero – if not below.

Yet, at the same time, we see many industries in which firms
do more or less the same thing. And among those firms offering more or less the
same thing, we often see very different levels of success and profitability. How
come? What explains the apparent discrepancy?

To understand this, you have to realise that the field of
Strategy arose from Economics. The strategy thinkers who first entered the
scene in the 1980s and 90s based their recommendations on economic theory,
which would indeed suggest that, as a competitor, you have to somehow be
different to make money. Over the last decade or two, however, we have been
seeing more and more research in Strategy that builds on insights from Sociology,
which complements the earlier economics-based theories, yet may be better equipped
to understand this particular issue.

Consider, for example, the case of McKinsey. Clearly, McKinsey
is a highly successful professional services firm, making rather healthy
margins. But is their offering really so different from others, like BCG, or
Bain? They all offer more or less the same thing: a bunch of clever, reasonably
well-trained analytical people wearing pin-striped suits and using a
problem-solving approach to make recommendations about general management
problems. McKinsey’s competitive advantage apparently does not come from how it
differentiates its offering.

The trick is that when there is uncertainty about the
quality of a product or service, firms do not have to rely on differentiation
in order to obtain a competitive advantage. Whether you’re a law firm or a
hairdresser, people will find it difficult – at least beforehand – to assess how
good you really are. But customers, nonetheless, have to pick one. McKinsey, of course, offers the most uncertain
product of all: Strategy advice. When you hire them – or any other consulting
firm – you cannot foretell the quality of what they are going to do and
deliver. In fact, even when you have the advice in your hands (in the form of a
report or, more likely, a powerpoint “deck”), you can still not quite assess
its quality. Worse, even years after you might have implemented it, you cannot
really say if it was any good, because lots of factors influence firm
performance, and whether the advice helped or hampered will forever remain opaque.

Research in Organizational Sociology shows that when there
is such uncertainty, buyers rely on other signals to decide whether to
purchase, such as the seller’s status, its social network ties, and prior
relationships. And that is what McKinsey does so well. They carefully foster
their status by claiming to always hire the brightest people and work for the
best companies. They also actively nurture their immense network by making sure
former employees become “alumni” who then not infrequently end up hiring
McKinsey. And they make sure to carefully manage their existing client
relationships, so that no less than 85 percent of their business now comes from
existing customers.

Status, social networks, and prior relationships are the
forgotten drivers of firm performance. Underestimate them at your peril. How
you manage them should be as much part of your strategizing as analyses of
differentiation, value propositions, and customer segments.

Thursday, 5 September 2013

Last week I was interviewed by a journalist from Korea’s
Maeil Business Newspaper (the local equivalent of the Financial Times). After
quite a lengthy interview, he ended with the question “How would you define a ‘great
company’?”
At the time
I thought it was a bit of a lame question, but that my answer to him was at
least as lame: I babbled something that I would 1) judge a company by its
performance – a long-term record of above-average profits – and 2) that
employees should really be enjoying being part of that organisation.

As said, at the time I thought it wasn’t my sharpest
answer of the day, but when I thought about it for a while, afterwards, I
started to really like the question; and even appreciate my answer to it! This
might be my memory playing dirty tricks on me – in a feeble attempt to protect
my self-image – but, admittedly, if asked today, I would likely give more or
less the same answer to that superb question.I think most would agree that you cannot say some
firm is a great company when it is habitually underperforming but, to me, great
financial performance is not enough. At the end of the day, an organisation is nothing else than a
collection of individuals working (more or less) together. If the people who
constitute the organisation do not enjoy being part of it, I have a hard time
seeing it as a great company.I realise
some of you might prefer to bring customer satisfaction into the mix, if not
other stakeholders. Yet, to me, employee satisfaction is the pivotal point of
departure. The legendary founder of Southwest Airlines – Herb Kelleher – used
to proclaim that employees (“not customers or shareholders”) were most dear to
him. That’s because he figured, if you have happy employees, they will make
your customers happy. And happy customers will come back, which will eventually
make your shareholders happy too (and, not coincidentally, Southwest had a
generous profit-sharing scheme, basically turning employees into shareholders).
Southwest has been outperforming its peers for decades.Yet, most of
us – including the stock market – still underestimate the power of employee
satisfaction. Professor Alex Edmans – my new colleague at the London Business
School – recently published a study that examined the effect on future stock
returns of a company making it onto Fortune’s list of “100 Best Companies ToWork For in America”.* He found that such a company subsequently generated
3.5 percent higher stock returns per year than their peers. This finding
suggests two things: 1) this employee satisfaction thing really works; having happy
employees eventually culminates into hard stock returns, but also 2) that the
stock market still undervalues its importance. The stock market habitually does
not anticipate these extra earnings, owing to employee satisfaction (even though
the list of 100 Best Companies To Work For is public knowledge). To conclude: there is money to be made from employee
satisfaction. Let’s all get rich and happy – be it not necessarily in that
order.

Friday, 5 July 2013

Richard Hunt and Mat Hayward fom the University of Colorado were interested in employees who asked
their employer for a loan, because they had no money but, for instance, had to
buy a car, pay for their daughter’s wedding, medical bills, buy food and
utilities, or faced home eviction. Therefore, they undertook to survey and
interview small and medium-sized building contractors in Colorado. No fewer than 67 percent of companies lent at
least one of their employees money, with an average of about $1,100. Hunt and
Hayward looked at 83 of them in more depth.

The first thing they found out was that, of the 459 loans
that these 83 companies in combination handed out to one of their employees, no
fewer than 57 percent were completely informal; meaning without any contract or
any other formal enforcement mechanism. Why would firms do this? Even if they
wanted to lend them money, why not give them a contract for the loan? This was
puzzling because making it an informal, instead of formal loan with a contract,
left the employer vulnerable to cheating by the employee. Because the employee
simply could not pay back, or eventually even somehow inform the tax authorities
(since informal loans are illegal). Why would employers voluntarily take that
risk?

Hunt and Hayward theorised that employers granting the loan
sometimes deliberately make themselves vulnerable towards the employee - by
choosing an informal arrangement rather than a contract – to solicit trust and
commitment from the employee. Granting a loan to a valuable employee in his
time of need and do that in a way
which explicitly makes the employer itself vulnerable could create substantial
commitment and reciprocity from the employee, grateful for the loan and
honoured by the trust placed upon him.

In conformity with this theoretical perspective, Hunt and
Hayward found that informal loans were indeed more often extended when the
employee needed the money for something personal and emotional, such as a
wedding, a graduation, or to pay medical bills. When the loan concerned buying
stuff (e.g. a car), paying off a credit card debt or rent, employers more often
resorted to a formal contractual loan.

Moreover, Hunt and Hayward conjectured that employers would
be more likely to make such an informal loan (rather than a formal,
contract-based one) to employees who they were more eager to keep. And indeed
they found that the informal loans were more often extended to better
performing employees; those that were neither very young nor old (but just the
right age to be both experienced and still have many productive years ahead of
them), and at a time when the firm was most dependent on them, because it was
still relatively new and small, and did not yet have a big backlog in terms of
outstanding work assignments.

The question is: Did it work? Does extending an informal
loan – at thus putting yourself at risk of being cheated on – result in
improved (financial) performance? Hunt and Hayward showed that the answer is a
resounding yes: their findings indicated that employers were better able to
retain employees to whom they had extended such a loan. Furthermore, their
calculations showed that it resulted in enhanced employer profit. Hence, making
yourself vulnerable (by not asking for a formal contract) eventually paid off
in financial terms.

Paper presented at the “Sumantra Ghoshal Conference for Managerially Relevant Research” at the London Business School
Our vulnerability is my gain: Linking exchange parties’ vulnerability to informal transactions and firm performance. Richard Hunt & Mathew Hayward (University of Colorado at Boulder)
Paper summary published with permission from the authors.

Wednesday, 26 June 2013

It is well-documented in the literature on labour markets
that personal connections, friendships, and other types of networks matter a
lot for finding a job. For example, applicants with friends in the recruiting organisation
are more likely to get a job offer.

This may be perfectly rational for the recruiting firm; the
friends of the candidate in the organization can be a great source of
information about the applicant. As a result, the firm can be more assured of
the job qualities of the person. Put differently, the candidate will pose less
of a risk – in terms of potentially turning out to be a hiring mistake – if he
or she has friends in the firm who have provided inside information. Therefore,
employers may be more eager to hire new people who already have friends in the
firm.

But professor Adina Sterling from Washington University suspected there might be another reason why
job applicants with friends in the firm might be more attractive to an employer
than those without. For quite a few jobs – especially if it concerns newly
recruited MBA students – applicants will simultaneously apply for multiple jobs
and then pick the most attractive offer they receive. And this can be very
costly for a firm: the recruitment procedure can be very expensive, with
multiple rounds of interviews and tests, but the time the candidate “sits on an
offer” before eventually rejecting it may also precisely be the time that the
numbers 2 and 3 on the list also secure and accept offers elsewhere. Therefore,
understandably, firms are eager to limit the number of rejections they receive
from candidates to whom they offered the job, and if they get rejected they
want it to happen asap.

And Adina, who did a lot of interviews among employers,
theorized that prospective employers would figure that candidates who already
have friends in the firm might be more likely to accept an offer or, if they do
reject it, do so soon. That is because the internal friendships might make them
more attractive as an employee but also because the candidate has a reputation
to protect with his or her friends, and feel an obligation towards them and the
firm.

But that’s a nice theory and thought, but how on earth can
you examine that? Because how could you statistically separate the two effects
of 1) employers gain information about a candidate from his or her friends, and
2) the friends might make the candidate more likely to accept an offer?

To solve this problem, Adina chose a clever research
setting. She looked at a 158 MBA and law students who had just completed an
internship with a company, and then examined whether having friends in that
company made them more likely to receive an offer from that firm. This was a
clever setting because reason number 1 (gaining information about the candidate
through his friends) no longer plays a role here; the employer already knows
the candidate very well due to his recently completed internship! Hence,
whatever effect is left could be attributed to reason number 2.

Adina indeed found that having friends in the company made
it more likely that the applicant received an offer. Overall, her findings indicate
that reason number 2 (friends make it more likely that the candidate will
accept) is also an important consideration for prospective employers.

Paper to be presented at the “Sumantra Ghoshal Conference for Managerially Relevant Research” at the London Business School
Friendships and Strategic Behavior in Labor Markets, Adina Sterling (Washington University)
Paper summary published with the author’s permission.

Tuesday, 18 June 2013

Ample research has shown that informal connections between
people have a substantial influence on economic life, in terms who deals with
whom and how well they perform. We call this “social embeddedness”, meaning
that we are all embedded to different degrees in various networks of people,
which influences our behaviour and success. One dimension which in a business
context has received a lot of research is whether people have a joint
educational background, particularly whether they are alumni from the same
academic institution.

Guoli Chen, Ravee Chittoor and Bala Vissa thought that this
embeddedness research that is focused on educational background could perhaps
be especially valid in a Western context (where most of the research has taken
place) but that in a different context, such as India, different types of
affiliations might also play an important role. Specifically, they wanted to
focus on the role of caste (i.e. people being of the same or different castes)
and language (in terms of people sharing the same regional dialect).

Research setting:
Equity analysts in IndiaTo examine these different dimensions of inter-personal
networks, they focused on a particular set of people and relationships, namely
equity analysts. Firms listed on the stock exchange will often be followed and
evaluated by analysts, as employed by banks, who make buy and sell
recommendations to the public regarding the company’s stock.

Perhaps the most important task of such an equity analyst is
to forecast – as accurately as possible – the future earnings of the firm.
However, to make an accurate forecast, an analyst often has to at least partly
rely on information received directly from the company; not seldom in the form
of personal conversations with the Chief Executive. And Guoli, Ravee and Bala
suspected that when the analyst happened to share the same background with the
company’s CEO it would be much easier for him or her to get access to the CEO
and his company information; making his earnings forecasts more accurate.

Findings

They tested this suspicion on a sample of 141 Indian firms,
followed by a total of 296 equity analysts, between 2001-2010. First of all,
they found clear evidence that equity analysts that are alumni of the same
academic institution as the company’s CEO were indeed able to make much more
accurate forecasts. But, in addition, the same was true for analysts who shared
the same background in terms of caste, and in terms of regional language.In fact, the effects were roughly the same
size, meaning that these old historical patterns (around caste and language)
were just as important in India as the more contemporary ones (i.e. university
affiliation).

They then examined the conditions under which these
different types of informal ties mattered more or less or whether such ties
were indeed always beneficial. They found that older CEOs – who could be
expected to be influenced more heavily by traditional patterns – were more
susceptible to issues of caste and language than younger CEOs. They were less
influenced by joint academic affiliation. Hence, although these old historical
patterns matter a lot in India; they matter less for younger people, who are relatively
more susceptible to joint academic affiliation.

In addition, they found evidence that these informal
relationships were particularly beneficial if it concerned a truly Indian firm
(part of a traditional business group). In contrast, such informal ties hurted
more than they helped, when the firm in question was an Indian subsidiary of a
Western multinational corporation.

Overall, what Guoli, Ravee and Bala’s research shows is
that, in a country like India, old historical social structures still matter a
lot in the world of business, especially when it concerns firms that are part
of a traditional business group. The effect of language (which is analogous to
ethnicity) was particularly potent. These effects may begin to matter a bit
less for younger people (i.e. since they were especially strong for older CEOs)
but they still wield considerable influence on economic life.

Paper presented at the “Sumantra Ghoshal Conference for Managerially Relevant Research” at the London Business School.
Which old boy network matters? Basis of social affiliation and the accuracy of equity analysts’ earnings forecast of Indian firms.Guoli Chen (INSEAD), Ravee Chittoor (Indian School of Business), Bala Vissa (INSEAD)
This paper summary is published with permission from the authors.

Saturday, 1 June 2013

We hear more and more talk about how the traditional model of business schools will be annihilated by the disruptive innovation of on-line education, so-called MOOCs (massive open on-line courses). An increasing number of voices can be heard to proclaim that business schools with their lectures and study groups are doomed, antiquated, overpriced, and that people who doubt that are just in denial and one day will wake up finding themselves obsolete and plain wrong.

And, arguably, case studies on the effects of disruptive innovation conducted in industries ranging from airlines and newspapers to photography and steel mills, have shown that often the established players in the market are initially in denial, slow to react, suffering from hubris and, eventually, face crisis and extinction.

Yet, when it comes to on-line education, and its potentially disruptive influence on higher education, including business schools, I doubt that on-line education will replace face-to-face lectures and study groups.

The arguments that people use to proclaim that traditional business schools will be replaced by on-line education include the notions that it is much cheaper, can be more easily accessed by a much wider audience, and customers (students) can access the materials wherever and whenever they want.

And this just reminds me of the printing press.

Oral lectures have been around since the times of Socrates and Plato. I am sure when the printing press was invented and became more widespread and accessible, an increasing number of voices could be heard to proclaim that such lectures and schools were going to be replaced by books. That is because books are much cheaper, can be more easily accessed by a much wider audience, and students can access them wherever and whenever they want. But they did not replace face-to-face lectures and study groups.

And that is because books and on-line educational resources offer something very different than the traditional lectures and school community. They are complements rather than substitutes. Of course the arrival of the printing press quite substantially changed schools and education; business schools without books would be very different than they are today. Hence, it would be naïve to think that on-line resources are not going to alter traditional business school education; they will and they should. Business schools better think hard how they are going to integrate on-line education into their courses and curricula.

But this means that it offers opportunities rather than a threat. And research on the effects of disruptive innovation – for example in newspapers – has also shown that established players who treat the arrival of a new technology as an opportunity, rather than as direct substitute, are the ones that are most likely to survive and prosper.

Friday, 17 May 2013

In our behaviour and beliefs, we are influenced by various hidden structures and characteristics of the people surrounding us. Over the past decades, for example, hundreds of studies on social networks and "small worlds" have shown that with whom you have had prior relationships, and how these people relate to each other, influences the information we receive, how much personal power we have, how likely we are to find a job, get promoted, how creative and innovatie we are, and so forth.

This research on social networks basically draws lines between you and the people you know, and lines between those people you know who also know each other; lines between them and other people you don't know at all, etcetera, to reveal very different structures. We call these structures networks with or without "structural holes", with more or less "indirect ties", "network closure", and so on.

Ample research has also revealed that, just like individuals, the same type of structures influence firms in their behaviour and performance. In this case, the lines between different firms - referred to as "social ties" - can be determined by prior alliances between these companies, or shared members of their boards of directors (so-called board interlocks), or some other cooperative tie. Firms may not always realise it, but their strategic choices and success can be heavily infuenced by these social networks.

What a former PhD student of mine - Kai-Yu Hsieh (now an assistant professor at the National University of Singapore) - and I did is similar but also very different from this social network research. We started to draw lines between the different firms in an industry, not based on "social ties" but based on who competes with whom. Some firms in an industry namely compete directly with each other where others don't. For example, in the pharmaceutical industry, a firm making anti-epileptic drugs and cardiovascular drugs would be competing with another firm that makes cardivascular drugs but not with a firm that makes antibiotics medicine. The firm's competitors, however, could also be competing with each other, for instance if both also happened to make cancer drugs. The point is that, drawing lines between the different firms in various industries also revealed remarkably different structures - just like social networks do. And we wanted to find out if organizations, in their behaviour, are also influenced by such competitive structures; which we labeled "the structure of competition".

And the answer is "oh yes".

We deliberately selected two very different industries for which to compute these competitive structures. We analysed whom competes with whom among computer hardware manufacturers in Taiwan. And we computed the exact same structures for pharmaceutical firms in China. The type of strategic behaviour that we chose to analyse through these competitive structures was imitative market entry: how inclined would these firms be, dependent on their structure of competition, to follow each other into new markets? Or might certain type of structures induce them not to imitate each other at all, and in fact stay out of certain markets altogether?

Remarkably, in these very different industries the exact same types of competitive structures led to the exact same types of strategic behaviour. And the influence of the structure of competition was substantial: firms could display completely opposite behaviour when facing different structures (flipping from a strong inclination to imitate to an inclination to do the opposite of others).

We interviewed people in these industries to find out why these structures were influencing their behaviour so heavily. The first thing we found out was that, in spite of their strong influence, managers were not aware of the different type of structures. But they were aware of their influence. Our interviews suggested that operating within a particular structure seemed to leave a particular "imprinting effect" on a firm, making it more or less aggressive in its market behaviour and towards its competitors.

In this study, we analyzed the strong influence of these hidden structures of competition on firm's imitative market entry behaviour, but it seems likely that - just as in the case of social networks - they might heavily influence a whole range of other strategic variables and behaviours. Hence, we see our research - due to appear in the academic journal Organization Science - as just a first step to uncovering the hidden influence of the structure of competition on economic life.

About this Blog

Freek Vermeulen is an Associate Professor of Strategy and Entrepreneurship at the London Business School. FREEKY BUSINESS probes what really goes on in the world of business, once you get beneath the airbrushed façade. It examines the people that run companies – CEOs, managers, directors – and dissects the temptations, the influences and the sometimes ill-advised liaisons and strategies of corporate life.